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Beyond Good Intentions: Why Diversity Is Vital In Investment Decisions

OVERVIEW

A large and still increasing body of research shows the benefits of diversity in all types of organizations. Whether from diverse perspectives, differentiated behavior or access to distinctive networks, diversity can lead to better decision making and increased profitability, making it an increasing priority in investing and financial services.

“When you have diverse teams, they are generally more effective at finding and implementing solutions,” says Meredith Jones, partner and global environmental, social and governance (ESG) practice leader at Aon. “And that can mean tangible benefits in both the corporate and investment world.”

For example, a Boston Consulting Group study found that companies with more diverse management teams — including a broad range of backgrounds, ethnicities and gender — have 19 percent higher revenue due to innovation. At companies where more than 20 percent of top managers are women, share prices rose more over the previous decade than their peers, according to another study by Credit Suisse.

A number of institutional investors have already recognized the benefit of investing with diverse managers, with some establishing dedicated women- and minority-owned asset manager programs. But work remains to be done. Recent research found women- and minority-owned fund management firms manage just 1.3 percent of assets in the $69 trillion asset management industry.

Jones says the recent conversations around social and economic justice have further highlighted the dearth of diversity in the investment industry, and led many institutional investors to ask, “‘What more can we do?’”

Despite dedicated programs, and some state-level legislation, that focus on investing in diverse-owned firms, Jones says noticeable increases in diversity have been elusive, likely because many of these well-intentioned programs focus on the final stage of the asset management funnel.

“We have realized that investment industry participants need to take a more holistic view of diversity and support the development of diverse asset managers at all of the major inflection points on the fund launch pipeline,” says Jones. “In a more supportive asset management ecosystem, more women- and minority-owned firms will be able to launch and scale.”

IN DEPTH

The benefits of diversity show up in the investment world in a few different ways.

“Diversity can drive differentiated investment behavior,” says Jones. “Women, for example, might make investment decisions that can help diversify portfolios and differentiate returns. Experience and background can also shape decision making, increasing diversification.”

Diverse firms may also provide important differentiation in deal flow. Where competition for investments is fierce, in private equity or venture capital, for example, having a diverse network can help unearth attractive but less competitive deals, and multiples may be lower as a result.

And the fact that many diverse firms are, on average, smaller means they can also be nimbler, allowing them to react more quickly to market shifts.

Because of these differences, women- and minority-owned hedge funds, mutual funds and private equity firms are disproportionately represented in top quartile performance figures, a 2019 study from Harvard University’s Bella Research Group found. And diverse private equity funds outgained median performers in 78.6 percent of the years studied, according to a 2019 study by Aon and the National Association of Investment Companies.

So what will it take to increase marketplace representation of women- and minority-owned asset managers?

Deepening The Pool Of Minorities In The Investment Industry

Boosting the assets in diverse investment funds — and creating a larger set of opportunities for investors — starts with more investors recognizing why diverse managers add value and developing an investment process that supports investing in diversity.

From there, increasing diversity in asset management requires nurturing interest in the industry with women and minority students in college and graduate school, or even earlier, says Jones. “Research shows that women, for example, start opting out of topics of study that would lead them to a career in financial services at age 11,” she says. “So, while the intervention and internships at the college and graduate school level are great, it may not be happening early enough.”

And once diverse individuals enter the investment industry, the second inflection point is obtaining the experience and track records needed for them to ultimately launch their own women- or minority-owned funds.

Nonminority financial services organizations are the proving ground for diverse investment professionals, says Jones. This is where inclusive hiring practices — ensuring diversity within cadidate pools and interviewing panels, for example — and promotion practices become critical. “Tracking and encouraging the development of diverse teams within nondiverse firms, especially in portfolio management and investment analysis roles, provides opportunities for women and minorities to gain the critical skills and track record required for a successful fund launch — and benefits the current asset management firm as well,” Jones adds.

Good Intentions, Old Habits

Institutional investors often have good intentions about using diverse asset managers. The issue is one of implementation, according to Russ Ivinjack, global head of fund management at Aon.

What prevents investors from choosing diverse asset managers? People are creatures of habit.
“Investors tend to work with the people they’ve always worked with — whether they’re in the endowment, foundation, corporate pension or public pension space,” says Ivinjack.

Unconcious bias has also been shown to affect our judgement, influencing decision making and nudging us unknowingly toward what’s familiar and comfortable.

Brand also comes into play. “Decision makers may be swayed by a firm’s brand over its performance metrics, and that favors the larger, more traditional asset managers.”

Making progress in manager selection calls for widespread behavior change. “Organizations have a responsibility to their stakeholders to choose a partner with the best performance and diversity of expertise and experience. Social affiliation or a long history are no longer enough to justify these choices,” adds Ivinjack.

Goals Over Quotas

As they look to increase allocations and exposure to diverse asset managers, some investors might be tempted to look strictly at surface metrics. For example, some investors focus primarily on ownership stake, requiring 51 percent-plus woman or minority equity. But that approach has limits, and could even hinder the goal of increasing women and minority participation, says Jones.

“In a perfect world you would like to see both fund management and fund ownership, reaping the benefit of diversity within the investment framework from a firm that also has majority ownership by women or minorities,” she says.

Focusing too tightly on that 51 percent metric, though, might shrink the pool of eligible, diverse asset management talent. “It also means that a group of individuals that has been historically disadvantaged is expected to front the majority of the cost of getting a firm up and running,” says Jones. And given the growing appeal of being seen as a diverse organization, there’s a risk of some firms using questionable tactics to appear women- or minority-led — such as granting ownership to noninvestment professionals, or even family members. So ownership is a helpful indicator, and something to strive for, but requires a thoughtful approach, says Jones.

A better approach is casting a wide net, recognizing, for example, that 30 percent to 40 percent minority ownership is better than 10 percent or even none at all, and simultaneously focusing on who exactly manages the money, she says.

Earning Diversity Dividends

Encouraging diversity in business has proved to be more than a laudable social objective: diversity yields real financial benefits. In asset management, that can mean higher returns, differentiated deal flow and lower capital costs.
The effort to increase minority involvement in asset management — like other areas of business — must be an ongoing one. And it’s not a simple matter of quotas or metrics. Businesses must continually assess their progress and refine their efforts to build diverse opportunities and participation. In the investment industry, as in the corporate world, those efforts to encourage diversity will pay real dividends.

“The hard part is that first move, the first leap,” says Ivinjack. “With good change management, from there you can start to build it into your organization’s muscle memory.”

The post Beyond Good Intentions: Why Diversity Is Vital In Investment Decisions appeared first on The One Brief.


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